The Appraisal Betrayal

The growing gap between a high-end home's sale price and its appraised value can prompt potential buyers to walk away; those who decide to buy anyway may end up with an unwelcome mortgage surprise

By

AnnaMaria Andriotis

Jan. 24, 2013 8:20 p.m. ET

What's that $1 million house really worth? Depends who you ask.

ENLARGE

SURPRISED: When Robert Lattas decided to refinance his home in Oak Brook, Ill., he found that its appraised value was unchanged, despite $200,000 in improvements, including hardwood floors and a new electronics system.
Sally Ryan for The Wall Street Journal

To determine the value of a property, appraisers are supposed to review purchase prices of similar, nearby homes that sold in the past six months. But when a property is much pricier than others in the neighborhood, it can be hard to find similar examples close by. As a result, their asking prices are often out of whack with values that are later determined by appraisals.

"The higher you go up the ladder in value generally the less data you have," says
Danny Wiley,
chief appraiser for LSI, an appraisal-management company based in Irvine, Calif.

To find relevant numbers, appraisers in many cases have been digging up older sales as far back as five years ago, consulting current listing prices that might not reflect what buyers are actually paying for a property and even looking at sales prices in other markets.

Further complicating matters, some luxury real-estate values are partly determined by the services and amenities in that neighborhood. City cutbacks in police patrols, fire services, park maintenance and school-district funding can also contribute to lower property values.

ENLARGE

Part of Mr. Lattas's new electronic system is shown.
Sally Ryan for The Wall Street Journal

For sellers and buyers, the process often results in an appraisal amount that's below the agreed-upon purchase price of a home. Lenders, in turn, will typically lower the mortgage amount that they'll give a buyer, leaving the buyer to make up the difference, often with a larger down payment. Another scenario: The buyer refuses to pay more than the appraised amount and renegotiates the purchase price with the seller. And if that fails, buyers can decide to walk away from the deal.

On average, one-third of real-estate agents said the appraisal process resulted in buyers and sellers delaying or canceling contracts or renegotiating to a lower sales price last year, according to a National Association of Realtors' monthly survey of roughly 3,000 agents. That's up from less than 10% in 2008.

Experts say this figure could grow going forward as the luxury real-estate market continues to surge. Appraisals can undervalue properties when markets are rising because they look backward at lower valuations, says
Mark Fleming,
chief economist at
CoreLogic
,
a real-estate analytics company. Some appraisers may not adjust for the discrepancy, he says.

It's not just home purchases that are at risk. Homeowners trying to refinance can also be burned. With private jumbo mortgages, if the appraisal indicates that the borrower's loan amount is more than 80% of the value of the home, the borrower will likely have to put more money down if he wants to proceed. In other cases, a lower appraisal could keep borrowers from getting the lowest rate possible.

After buying a $2.3 million home in Oak Brook, Ill., last year,
Robert Lattas
decided to refinance his mortgage to lock in a lower rate. Mr. Lattas, a real-estate attorney, expected the home's value to increase since he had pumped $200,000 into improving the property. To his shock, two appraisers told him the upgrades—which include hardwood floors and a new electronics system—had left the home's value unchanged. Because the appraisal didn't lower his loan-to-value ratio, and despite his high credit score, Mr. Lattas says he's going to end up with a mortgage rate that's a quarter of a point more expensive than the lowest rates available. "It's a lot of money when you're talking about a [big] mortgage," he says.

To protect themselves from a surprise appraisal, buyers and sellers can take some steps early on.

• Buyers, add a contingency clause in the contract: Include a statement in the contract that guarantees the buyer will receive the initial down payment back if the appraisal value is below the offer. That also leaves open the option of renegotiating or walking away from the deal without losing those funds.

• Sellers, research county records: Counties assess home values to help determine the property taxes a homeowner will pay. Appraisers take that assessment into account while determining a valuation for the home. It's possible that the county's figures could be wrong—and could be keeping buyers from purchasing the home.
Daniel Fries,
an Atlanta appraiser who specializes in luxury properties, says a client asked him to determine the value of his 50,000-square-foot property that was on the market for years. Mr. Fries says he found that the county had overvalued the property and assigned property taxes that were $50,000 more per year than the property's current value would warrant.

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